Nicolas Renaud
Applied Private Equity and Venture Capital
Course 2
And Now for Something Completely Different…
Basic Financial Concepts
Consolidation
Please see any good accounting book
Holdco
Sales: 1100 EBITDA: 110 NI: 16.5
Subsidiary
100% 60%
Company 1 Sales : 1,000 EBITDA : 100 NI : 10
Company 2 Sales : 100 EBITDA : 10 NI : 10
Company 3 Sales : 10 EBITDA : 1 NI : 1
30%
Company 4 Sales : 200 EBITDA : 20 NI : 2
10%
Investment Associate
Acquisition accounting
Please see any good accounting book
Assumes acquisition for EV of 250 financed by 100 of debt and 150 of equity
Repayment of Debt
-50 Company
Cash: 10 Debt: 50 Equity: 100
Company Cash: -40 Debt: 0 Equity: 100
Company Cash: 210 Debt: 100 Equity: 250
Company Cash: 0 GW: 110 Debt: 100 Equity: 150
Issuance of Debt and
Equity +100 debt +150 equity
Payment of purchase
price -210
P&L Overview
Evolution of Sales Evolution of EBITDA
Summary P&L
As of December-31 Historical Projected CAGR
$ M 2009 2010 2011 2012 2013 2014 2015 09 - 11 11 - 15
Revenue 33.1 35.9 37.1 36.0 41.1 47.5 51.5 5.9% 8.6%
Growth 8.6% 3.2% (2.9%) 14.3% 15.5% 8.3%
COGS (13.6) (13.8) (13.3) (13.8) (15.3) (17.2) (18.2)
Gross Profit 19.5 22.1 23.7 22.2 25.8 30.3 33.2 10.3% 10.8%
Gross Margin 59.0% 61.6% 64.0% 61.7% 62.7% 63.9% 64.6%
SG&A (4.4) (4.8) (4.3) (4.5) (4.6) (4.9) (5.2) (1.3%) 4.9%
Overhead Costs (4.5) (4.5) (4.5) (4.5) (4.6) (4.8) (4.9)
EBITDA 10.6 12.8 15.0 13.2 16.5 20.7 23.2 18.6% 11.6%
Adjustments vs Special Purpose Financials - (0.1) (0.4) - - - -
EBITDA adj. 10.6 12.7 14.6 13.2 16.5 20.7 23.2 17.2% 12.3%
EBITDA Margin (excl new inv.) 32.2% 35.5% 39.4% 36.6% 40.1% 43.5% 45.0%
33.1 35.9 37.1 36.0 41.1 47.5 51.5
(5.0%) - 5.0%
10.0%
15.0%
20.0%
0 25 50 75
2009 2010 2011 2012 2013 2014 2015
Net Sales Growth
10.6 12.7 14.6 13.2
16.5
20.7 23.2
0%
20%
40%
60%
80%
100%
0 10 20 30
2009 2010 2011 2012 2013 2014 2015
EBITDA EBITDA Margin
Summary Balance Sheet
Balance sheet is always divided between short and long term
Balance sheet present a Photography of the company
Summary Balance Sheet
$ '000 - As at 31 Dec 2011
Assets Liabilities
Accounts Receivables, Net 2,405 AP & Accrueds 1,635
Prepaids & Other Current Assets 397 Accrued Capital Expenditures 116 Other Current Liabilities 625 Total Current Assets 2,802 Total Current Liabilities 2,377
Property & Equipment, Net 60,639 Other LT Liabilities 13,236
Other Assets 416 Advances from Parent 482
Shareholders' Equity 47,763
Total 63,858 63,858
Cash Flow Statement
CASH FLOW STATEMENT
Years ended December 31,
(in US$'000) 2012F
Net income 3,667
Depreciation and amortization 5,519
Capitalized Interest -
Working Cap Requirements 27
Operating Cash Flow 9,213
Sale of Fixed Assets -
Capital expenditures (3,292)
Investing Cash Flow (3,292)
Purchase of Performance Shares -
Repayment of new senior debt (1,267)
Repayment of new subordinated debt -
Capex Financing (net) 300
Financing Cash Flow (967)
Total cash flow 63
Balance Sheet & Cash flow Statement
SUMMARRY BALANCE SHEET
$ '000 - as at 31 dec 2011
Assets Liabilities
Cash Overdraft etc
Accounts receivables Accounts Payables
Inventory ST Debt
Prepaid & other Other
Current Assets Current Liabilities
PP&E LT Debt
Goodwill Equity
SUMMARRY CASHFLOW STATEMENT
$ '000 - as at 31 dec 2011 Net income
Depreciation and amortization Capitalized Interest
Working Cap Requirements Operating Cash Flow Capital expenditures Investing Cash Flow Repayment of debt Issuance of debt Dividend
Financing Cash Flow TOTAL CASH FLOW
BS and CF can be summarized using:
P&L items
Debt items
WC items
Capex items
Forecasting through Schedules
All important items can be adequately forecasted
using simple schedules
Debt Schedule:
Senior Debt - Beginning
Senior Debt Issued Senior Debt Repayed Senior Debt - End Interest on Senior Debt
Investment Schedule
PP&E Beginning
Maintenance capex Growth capex
Depreciation Ending Balance
Working Capital Schedule
Days of
Accounts Receivable Sales
Inventories COGS
Accounts Payable COGS
Enterprise Value
Entreprise Value - Net Debt
(all debts – Operating cash & cash equivalents) - Off balance sheet items
(unfunded pension liabilities, leasing obligations etc) - Minority interests
+ Investment in associate (at market value)
= EQUITY
Exercise
Which bank loan is best :
$1.0 M , capital payments of $200 k for 5 years and interest of 5% calculated on opening balance
$1.0 M , no capital payments until term and interest of 5.3%
calculated on opening balance
Quick Questions:
Define WC Define GW
If risk free rate go up how are valuation affected?
The Different Financing Sources Available
In Canada / Us true Mezzanine is not
available due to absence of Mother – Daughter fiscal integration
The goal of the
entrepreneur is to lower as best as he can his cost of capital
Main strategy involve delaying as much as possible capital raising to optimise leverage
Some variation include:
– PIK – Revolver – Convertible
– Mandatory convertible – Hybrid
– Bullet – Sukuk
Equity
– Most expensive type of capital
– The only one available at the beginning and the cushion for debt investors
Subordinated Debt
– 13% - 18%+ fairly expensive type of capital – Similar to equity but with a tax shield effect
– Used primarily for tax reasons, to increase leverage, to avoid diluting entrepreneur
Senior debt / bonds:
– Cheapest source of capital
– Bank financing, subject to strict covenants
– Usually amortizing term loan, can be a Bullet or very fashionable currently reducing revolving facility
– Typically require a minimum equity cushion of 40%
Subventions 1
2
3
4
The different Financing Sources Available
What is Value
Value exclusively comes from economic profit
Value is not price
Companies create value by investing capital at rate of returns that exceed they cost of capital
– Spread between cost of capital and ROIC – Invested capital is CAPEX + WC
Economic profit is the true measure of a company value:
– (ROIC-cost of capital) * capital deployed – The goal is to maximize capital economic profit
Value of a company is the present value of economic profit:
– + invested capital of course
This is very different than price:
– Demand meets offer
– Sum of different expectations
– No equilibrium in markets + future based pricing 1
2
3
4
Cash Flow?
Income is not the primary goal per-se cash is the
real factor Net Income Overview
2012 2013 2014 2015 2016
Company 1 100 112 125 140 157
Company 2 100 109 119 130 141
Cash Flow Aproach
2012 2013 2014 2015 2016
Company 1 earnings 100 112 125 140 157
Net investment 25 28 31 35 39
Earnings - Investmnet 75 84 94 105 118
Company 2 100 109 119 130 141
Net investment 12 13 14 16 17
Earnings - Investmnet 88 96 105 114 124
Cash Flow vs. ROIC
If return on investment is constant, growth is essentially a factor of RONIC and investment
rate Initial Investment
$100 $20
Return on Investment
20%
Additional Investment
$10
Reinvest 50%
$1 Return on NEW
Investment 10%
GROWTH = RONIC * Inv. Rate
Cash Flow vs. ROIC (Cont’d)
Cash Flow Aproach
2012 2013 2014 2015 2016
Company 1 earnings 100 112 125 140 157
Net investment 25 28 31 35 39
Earnings - Investmnet 75 84 94 105 118
Implied RONIC 48% 48% 48% 48% 48%
Company 2 100 109 119 130 141
Net investment 12 13 14 16 17
Earnings - Investmnet 88 96 105 114 124
Implied RONIC 75% 75% 75% 75% 75%
Note: Returns favor higher reinvestment
Cash Flow Aproach
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Company 1 earnings 100 105 110 116 122 128 134 141 148 155 163
Net investment 25 26 28 29 30 32 34 35 37 39 41
Earnings - Investmnet 75 79 83 87 91 96 101 106 111 116 122
RONIC 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%
Company 2 100 102 105 107 110 113 115 118 121 124 127
Net investment 12 12 13 13 13 14 14 14 15 15 15
Earnings - Investmnet 88 90 92 94 97 99 101 104 106 109 112
RONIC 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%
Main valuation Methods
Main Valuation Methods
Multiples
• Easy to implement
• Less room for manipulation
• Imprecise / wrong
• Sometimes
difficult to find true comparables
Transaction multiples
• Easy to implement
• Difficult to obtain data for non listed companies
• Skewed by time
DCF
• Precise
• Theroretically corect
• Difficult to implement
• Lots of room for manipulation
LBO
• More of an
investment criteria than a valuation criteria
Free Cash Flow Formula
To measure the cash provided by the company it is important to
remember that you want it free of the capital structure of the company
EBITDA
Reinvestment into the business
-
Tax
-
Free Cash Flow Formula
EBITDA
• Closest measure to operational performance
• least subject to manipulation
Reinvestment into the business
-
• Capex
• Working cap
Tax
-
• Don t forget Depreciation tax shield
Discount Rate: WACC
The WACC is the best way to reflect for the structure of capital in the discount rate
Return on capital to debt holders Free Cashflow
Return on capital to Equity holders
DEBT EQUITY
Discount rate
WACC 𝐷 (1-τ) k
dk
e𝐷 + 𝐸
𝐸 𝐷 + 𝐸
= +
Discount Rate - Risk
Risk is a measure of uncertainty
As private equity investors we are not concerned about systemic risk but only about company specific risk
In finance, risk is a measure of the probability and magnitude of a difference between actual returns and expected returns
• There is 2 type of risk:
Systemic risk
Company specific risk
Variance
Note: risk is as much a question of perception as a question of actual risk
The measure of the actual risk of a company is unavailable to investors
Types of risk
How to measure risk
Bank risk Kd:
• Given to you by the bank who will measure ability of business to repay debt and add the specific risk (+ a margin) to systemic risk (LIBOR)
• Ex: LIBOR +300bps
Equity risk Ke:
• Most used model is CAPM : Ke = rf + β (specific return)
• Empirical evidence suggest specific return to be at 4% in equity markets
• Not really relevant in practice and more arbitrary measures are used
• 9% for equity markets
• 15 – 25% for private equity
• More for VC
Continuing Value
Can represent most of the value of the DCF
Very sensitive to small changes in assumptions
Exit multiple
Simple
Can be misleading and should be adjusted if the entry multiple incorporate synergies or significantly different state than forecasted at exit (remaining capacity etc)
Perpertuity:
CFt+1 / (WACC-g)
effectively implies that RONIC = WACC 1
2
Exercises for next time
Can represent most of the value of the DCF
Very sensitive to small changes in assumptions
Demonstrate NPV formula given AoA
Demonstrate Perpetuity formula
Assuming a company worth $1.0 Bn has $500m of debt what is the value of the Equity. Demonstrate given AoA
Fin a public company with Investment in associates and minority interest
Publicly Traded Comparables
key market comparables that are engaged in network and application optimization activities for telecom and other (DC, enterprise, WAN). These were split into 3 categories for valuation metrics discussion
(in USD) Trading Information
Stock Price Mark et Ent. Revenue EBITDA Gross
27/06/2014 LTM C ap. Value LTM C Y14E C Y15E LTM C Y14E C Y15E LTM LTM LTM C Y14 C Y15 LTM NTM/LTM 14/13 15/14 NTM/LTM 14/13 15/14
Hy per Growth
Palo Alto Networks $81.21 65.8% $6,259 $5,891 11.1x 8.7x 6.6x NMF NMF 40.3x $532 ($28) NMF 12.3% 16.4% 73.5% 35.9% 39.6% 32.2% NMF 78.0% 76.4%
A10 Networks $12.43 NA $746 $624 4.0x 3.2x 2.6x NMF NMF NMF $158 ($2) NMF (3.0%) 2.4% 76.7% 26.9% 35.6% 23.0% NMF NA NMF
Gigamon $19.30 (50.3%) $616 $473 3.2x 2.7x 2.2x NMF 19.8x 11.2x $146 ($38) NMF 13.7% 19.3% 76.7% 27.5% 24.1% 25.9% NMF (6.5%) 77.2%
Array Networks $1.55 126.2% $117 $91 2.2x 1.7x 1.3x 37.0x 12.5x NA $41 $2 5.9% 13.9% NA 77.2% 34.5% 30.8% 37.3% NMF 734.8% NA
Median: 65.8% $681 $549 3.6x 3.0x 2.4x 37.0x 16.2x 25.7x $152 ($15) 5.9% 13.0% 16.4% 76.7% 31.0% 33.2% 29.1% NMF 78.0% 76.8%
Mean: 47.2% $1,935 $1,770 5.1x 4.1x 3.2x 37.0x 16.2x 25.7x $219 ($16) 5.9% 9.2% 12.7% 76.0% 31.2% 32.5% 29.6% NMF 268.8% 76.8%
Developing EBITDA
Aruba Networks $17.78 0.4% $1,933 $1,633 2.4x 2.1x 1.8x NMF 9.5x 7.8x $679 $16 2.3% 21.9% 23.1% 69.4% 19.9% 23.7% 14.7% NMF 39.5% 20.9%
Barracuda Networks $31.50 NA $1,620 $1,489 6.4x 5.7x 4.9x NMF 23.7x 22.2x $234 ($0) NMF 24.2% 21.9% 77.0% 15.6% 14.9% 17.8% NMF NA 6.7%
Radware $17.13 17.2% $775 $608 3.1x 2.8x 2.6x 21.2x 15.6x 11.7x $199 $29 14.4% 18.0% 22.0% 81.1% 10.7% 11.6% 9.5% 46.8% 33.9% 33.5%
Infoblox $13.17 (67.7%) $718 $456 1.8x 1.8x 1.6x NMF 20.5x 10.8x $248 ($4) NMF 9.0% 14.7% 77.9% 1.9% 0.8% 16.4% NMF (34.8%) 90.8%
Sandvine $3.30 28.1% $496 $375 3.3x 2.9x 2.4x 12.3x 10.6x 8.3x $113 $30 27.0% 26.9% 29.4% 75.8% 18.7% 23.3% 16.5% 9.5% 45.0% 27.1%
Allot Communications $13.31 1.0% $439 $317 3.1x 2.7x 2.3x NMF 18.6x 12.9x $101 $1 0.6% 14.5% 18.2% 71.9% 19.5% 21.8% 14.8% NMF 151.4% 44.3%
Procera Networks $9.71 (36.2%) $198 $91 1.2x 1.1x 0.9x NMF NMF 8.2x $75 ($14) NMF 2.1% 11.5% 56.1% 17.9% 12.6% 16.1% NMF NMF 7.0%
Median: 0.7% $718 $456 3.1x 2.7x 2.3x 16.7x 17.1x 10.8x $199 $1 8.4% 18.0% 21.9% 75.8% 17.9% 14.9% 16.1% 28.1% 39.5% 27.1%
Mean: (9.6%) $883 $710 3.0x 2.7x 2.4x 16.7x 16.4x 11.7x $236 $8 11.1% 16.7% 20.1% 72.7% 14.9% 15.5% 15.1% 28.1% 47.0% 32.9%
Mature EBITDA
Cisco $24.70 10.6% $126,530 $96,970 2.1x 2.0x 1.9x 7.5x 5.9x 5.7x $47,202 $12,871 27.3% 34.5% 33.9% 59.2% 2.7% (0.2%) 4.6% 34.0% 3.9% 2.7%
Juniper Networks $24.47 16.6% $11,593 $9,984 2.1x 2.0x 1.9x 12.3x 7.7x 6.6x $4,780 $813 17.0% 25.9% 28.8% 62.9% 5.4% 6.7% 5.2% 73.8% 18.8% 17.0%
F5 Networks $111.11 18.7% $8,414 $7,790 4.9x 4.4x 3.9x 15.9x 11.5x 10.0x $1,592 $489 30.7% 38.4% 39.1% 82.4% 14.4% 16.3% 12.6% 43.7% 16.3% 14.6%
Riverbed Technology $20.43 30.8% $3,280 $3,327 3.1x 2.9x 2.7x 20.4x 9.1x 8.4x $1,060 $163 15.3% 31.9% 31.9% 73.3% 10.4% 10.2% 8.2% 96.4% 31.5% 8.1%
Margins Fundamentals
EV/EBITDA Valuation
EV/Revenue EBITDA Revenue EBITDA
Operating Metrics Growth
Date Ente r pr i se EV/LTM LTM EB I TDA
Anno unce d' Acqui r e r ' Tar ge t' B usi ne ss De scr i pti o n' Val ue' R e ve nue' EB I TDA ' Mar gi n
03/25/13 Oracle Tekelec Telephone service management software na na na na
02/15/13 Opera Software ASA Skyfire Labs [fka DVC Labs] Mobile video traffic software $155 37. 8x na na
02/04/13 Oracle Acme Packet Session border controllers provider $1,687 6.1x 27. 3x 22.5%
12/18/12 Cisco Systems BroadHop Policy control platforms for telecom na na na na
12/05/12 Redknee Solutions Nokia Siemens Networks (BSS business) Telecom carrier software assets $52 na na na
11/29/12 Cisco Systems Cariden Technologies Inc Telecom network design software $141 na na na
07/31/12 Allot Oversi Networks Caching and content delivery solutions $21 2.6x na na
07/16/12 CSG Systems International Ascade AB Telecom OSS software provider $19 1.2x 16.0x 7.5%
06/07/12 Citrix Systems Bytemobile Mobile traffic management software $435 8.7x na na
05/01/12 Allot Communications Ortiva Wireless Wireless infrastructure systems provider $11 1.4x na na
04/16/12 Marlin Equity Partners LLC Openwave Systems (mediation & messaging Telecom management software assets $55 na na na
02/20/12 F5 Networks Traffix Systems Telecom signaling systems provider $128 na na na
12/09/11 Thoma Bravo Blue Coat Systems Network application delivery optimization $856 1.8x 9.8x 18.7%
11/07/11 Siris Capital Group LLC Tekelec Telephone service management software $491 1.2x 9.2x 13.3%
06/17/11 Amdocs Limited Bridgewater Systems Telecom service control software $130 1.5x 8.0x 18.3%
12/10/10 PAETEC Formula Telecom Solutions Telecom billing software provider $13 1.6x na na
09/24/10 CSG Systems International Intec Telecom Systems Telecom billing software provider $267 1.1x 6.7x 16.1%
07/30/10 Redknee Solutions Nimbus Systems SL Telecom billing software provider $15 na na na
05/06/10 Tekelec Blueslice Networks Telecom data management software $35 na na na
05/06/10 Tekelec Camiant Inc Telecom network management software $127 na 7.6x na
10/13/09 Cisco Systems Starent Networks Wireless infrastructure systems provider $2,389 7.8x 19.7x 39.4%
04/30/09 Acme Packet Covergence SBC & SIP trunking hardware $22 2.8x na na
Ave r age $353 3. 2x 11. 0x 19. 4%
Me di an $128 1. 7x 9. 2x 18. 3%
Precedent Transaction Analysis
Precedent Transaction Analysis
(Figures in US$ millions)
Attractivity Band Concept
●
Attractively is a balance between growth and EBITDA maturity
1
Rapid improvement in EBITDA or mature EBITDA
Sale s G row th
Analysis of Valuation Categories
Market is Segmented in 3 clear categories
Hyper-Growth Unprofitable Companies
Growing Companies with Clear Path to Profitability
1 2
Revenue Growth: ~30%
Long-term path to profitability
1 2
Revenue Growth: 15% - 25%
Clear path to profitability and significant operating leverage
Valuation
Valuation based on growth and sales multiples
Comments
Unforgiving reaction to deceleration
Valuation
Valuation based on a mix of sales metric and forward EBITDA multiples
Comments
More stable market momentum
Low Growth but Highly Profitable Companies
1 2
Revenue Growth: ~8%
Currently profitable and mature EBITDA margins
Valuation
Valuation based mostly on EBITDA multiples
Comments
Less demanding valuations
229 204
218 25
40
139 138
165 13
26
110
279 248
263 30
49
169 165
195 16
32
132 EV/Revenue LTM
EV/Revenue 2014 EV/Revenue 2015 EV/EBITDA 2014 EV/EBITDA 2015 EV/Revenue LTM EV/Revenue 2014 EV/Revenue 2015 EV/EBITDA 2014 EV/EBITDA 2015 10-12x 2016 EBITDA
Preliminary Value Benchmarking
(in US$ mm)
Methodology Implied Enterprise Value
Hyper-Growth CompaniesModerate Growth CompaniesLow Growth Mature Companies
E
• Company is likely to be valued in the moderate growth category but currently there is a significant disconnect between its EBITDA-based and Revenue-based implied valuations
• Assuming current valuation environment continues, an IPO in Q2 2015 based on 2016E metrics would suggest a range of 220-240 based on Revenue multiples and 110-132 based on EBITDA multiples
Valuation Disconnect
DRAFT
V. Process Considerations
Process Objectives
Should a process subsequently and/or ultimately be undertaken, a successful process is typically expedient, minimizes disruption and realizes fair value for shareholders
In addition to achieving a high value for the assets, one may also desire a discrete and timely process
Critical to prioritize and find the proper balance between these objectives
Potential for a Disruptive Process
Minimize Disruption
Timely Completion
Certainty of Outcome
Attractive Structure
Maximize Value
Sale Process Alternatives
Potential for Value Maximization
Process Considerations
Shorter Process Longer Process
Concern?
Value Maximization
Greater access to a larger number of buyers requires significant investment in time and
resources to schedule meetings, disseminate information and provide each buyer with sufficient management access to solicit each party's view on value; creates better chance that winning bidder ends up being the party willing to pay the most
Market Risk/Timing
Exposure to an extended time frame increases risk of adverse market events affecting the process; consideration to known holidays and reporting requirements should be factored into timeline
Leaks
Leaks are a risk in any process and increases with the number of people and with the length of the process. Leaks can be disruptive to process - buyers walk, volatile share price, undue distractions
Employee Impact
Employees directly involved in the process will find that a majority of their time will be consumed with activities outside their day-to-day duties; a lengthy process may increase the risk of rumors and leaks and may adversely affect other employees and create uncertainty over future
Customer/Supplier Impacts Targeted Buyer Universe?
To the extent there is a limited buyer universe, a broad process may not be needed to maximize value, which would also minimize the risks associated with the market, potential leaks, employee distraction and customers/suppliers
Discrete Controlled Wide (Discussions with one interested
party)
(Simultaneous discussions with a group of interested parties)
(Wide open process with closed-bid deadline)
Advantages
Very limited disclosure
Minimize the uncertainty to employees and customers
Minimize ‘widely-shopped’
stigma
More control over process and timetable
Preferred approach of buyers (i.e., exclusivity)
High value for the business while maintaining manageable scope of process
Early indications of interest and price level for the business before proceeding with full process
Flexibility to change process, particularly with regards to selling the business to one buyer or several buyers
If sufficient interest, likely to obtain maximum value
Fairly expeditious process with uniform deadline
Widest exposure to potential buyers
Disadvantages
Negotiation tends to be sequential and can drag on
Difficult to create bidding tension
May not attract complete
universe of buyers Confidential data must be broadly disseminated
Considerable commitment of management time
Requires credible ‘walk-away’
alternatives
Process Alternatives
The duration of a process depends on the overall objectives and ultimately the type of process undertaken
Sale Process Alternatives
Stage 1
Surface Initial Indications of Interest
Organize process
Collect data
Develop potential purchasers list
Prepare Broadcast Letter/Teaser
Prepare CIM
Initial contact made to prospective purchasers
Signing of
CAs/distribution of CIMs
Management
presentation preparation
Data room preparation
Solicit non-binding expressions of interest
Determine a short-list of partners
Short-list candidates
Reciprocal management presentations
Reciprocal due diligence
Pre-acquisition agreement
Solicit final proposals
Negotiate final proposals
Select winning partner
Finalize definitive agreements
Execute definitive agreements
Closing Preparation Stage
Approach Stage
Due Diligence Stage
Negotiation/Closing Stage
3 - 4 weeks
3 - 4 weeks
3 - 4 weeks
3 - 4 weeks
Overview of a 2-Stage Auction Process
Stage 2
Finalize An Agreement With
DRAFT
Appendix
Unsolicited Considerations
Front Door Approach First - Buyers prefer to go through the
‘front door’ in order to source the target’s co-operation, the board support on price, and the opportunity for due diligence
– However, unsolicited offers tend to occur in situations where the bidder may be perceived to be the ‘enemy’ or where front door overtures have been rebuffed
• Most initial unsolicited bids are unsuccessful, but ultimately cause a change of control
Best Defence - The best defence against any unsolicited proposal is to have the Company’s “full value” already reflected in the marketplace – thus avoiding opportunistic advances
Advance Preparation – When a Company finds itself in a vulnerable position, it would be prudent for the Board to prepare for a potential unsolicited bid
Proxy Contest – Activist shareholders may also see
opportunities to push the Board into actions to augment value in short term
– Not necessarily aligned with all shareholders as their interests are short term in nature
Early preparations for an unsolicited takeover bid can significantly
enhance the effectiveness of a defence strategy
Defence Preparation
Understanding Alternatives – An appropriate Board response will only be possible if the Board has a full understanding of all of the company’s alternatives as early in the defence contest as possible
– Ideally prepared in advance of receiving a hostile bid – Time to respond to an unsolicited bid can be very limited
– True alternatives to an offer must be more favourable to shareholders
Preparation – An appropriate defensive strategy prior to receiving an unsolicited bid would include a preparation stage to establish key elements of the current environment:
– Clearly understand value proposition – Communicate message to market
– Identify likely suitors and White Knight candidates – Be prepared to review business in detail
Shareholder Value Team
Shareholder Value Team - Identify legal and financial advisors to work with senior
management and the Company’s Board or independent committee (a “Shareholder Value Team”) to carry out the necessary analysis and planning functions
The Shareholder Value Team should undertake certain initial preparations, including:
– Review existing protection mechanisms (shareholder rights plan, key contracts, etc.);
– Consider structural initiatives and their role in any hostile take-over attempt;
– Identify and analyze potential strategic partners; and
– Initiate a “share watch” program to monitor trading of the Company’s shares
In addition, the Shareholder Value Team should participate in the Company’s business review and initiatives to maximize value
The Shareholder Value Team should have the confidence of the Board of Directors and the authority to respond quickly in the face of an unsolicited bid or proposal
In response to an unsolicited bid or proposal, the Shareholder Value Team should quickly assess the strategic objectives of the offeror, estimate its maximum price payable, and analyze all aspects of any proposals
Before any bid is received, the Shareholder Value Team can take considerable steps towards an unsolicited defence review, and save valuable time should an unsolicited bid surface
Defense Preparation
Key management, legal, financial, and PR advisors
Consider potential candidates for a special committee Identify
Shareholder Value Team
Monitor share trading to detect unusual activity; may provide early warning
Identify key relationships: regulatory, political, customer, supply, lender notification/briefing requirements
Relationships should be established in advance to be able to act immediately, if and when required
Review shareholders’ rights plan
Buys time Establish Market
Intelligence Program
Receive and respond to calls, record source and nature of calls, monitor catalyst groups
Ensure shareholder sentiment is communicated to Shareholder Value Team Proactive Investor
Relations Program
Update business plan and conduct detailed business and financial review
Due diligence will be done both by the Company and a White Knight to assess value
Effective data rooms take time to assemble, which should be spent pre-bid Update Business
Plan
Refine list of potential White Knight candidates and determine the Company’s value proposition to each (ability to pay/synergies,
Planning Stage
The initial solicitation and screening will be structured to produce a sufficient range of qualified bidders so as to establish a competitive process
Tactical Objectives
– Once a group of prospective purchasers has been selected, the objectives become:
• Solicit expressions of interest
• Create urgency and tension by controlling buyers and maintaining a parallel process
• Develop negotiating strategies
• Pursue most serious buyer
• Verify candidates' financial capacity
• Engage in negotiations
Information
– Information is a tool used to motivate the buyer to bid with confidence – The seller should produce high quality and accurate information
– It is materially more difficult to motivate a buyer to submit an aggressive offer when the quality and accuracy of the information cause the buyer to be less confident and less certain about the prospects of a business
Process
– Process should not impair the buyers' willingness to bid aggressively – The sale process should be honest, fair and equal to all participants – All qualified bidders should receive the same information, should have
adequate time to evaluate the information and equal access to the key participants in the process. Otherwise, certain bidders may choose not to participate to the full extent, or not aggressively
– Management conflicts need to be addressed prior to launching the auction
Bid
Tension Bid
Rounds Initial
Contact Process
Tools Process
Objectives Info
Approach Stage
The approach will be made once the planning stage is complete, and solicitation will be done in a manner to facilitate a process consistent with tactical objectives
Initial Contact – Canaccord Genuity will initiate
– Approach approved buyers at senior level, as appropriate – Focus attention on opportunities presented by the Company
Process Tools
– If a prospective buyer's level of interest is sufficiently high, the initial call from Canaccord Genuity will be followed by a selling packet containing:
• Broadcast Letter/“Teaser”;
• Confidentiality Agreement; and
• Procedures Memo
Bid Tension
– Competition is a critical ingredient to developing full value for an asset
Bid Rounds
– A multi-phased process generates more aggressive bids
– A process which requires multiple indications of interest coupled with greater selectivity can generate incremental levels of aggressiveness with each phase (need to weigh against perception of a “never ending” auction)
– Clearly the appropriateness and extent of employing this approach is function of the level of interest
Bid Tension Bid Rounds Initial
Contact Process Tools Process
Objectives Info
Management
Presentation/Data Room 6 Definitive Agreement 4
Shareholder Lock-up 7
Exclusivity 5
Confidentiality Agreement 2
Buyer may pre-empt process and ask for period of
exclusivity to negotiate a transaction
May be provided at a late stage in the auction in return for an improved value or structure
Negotiations will ultimately result in finalizing terms in a Definitive Agreement
It is important for
management to remain open and uncommitted to all opportunities in order to help maximize value
May help if there are regulatory issues
Potential buyers will want a commitment from the key shareholders to sell at a specified price
Access to confidential materials/ management and employees
Reduces transaction risk to buyer and allows better evaluation of synergies
Detailed document articulating and supporting key selling points, business plan, financial forecast to assist a purchaser in evaluating the opportunity and assessing value in light of public information available
Binds both parties to maintain confidentiality of the materials exchanged and nature of the process
Controls public disclosure and restricts discussions among competing purchasers
Process Tools
A summary of the opportunity and key selling points sent immediately following initial contact with a potential purchaser
Entices potential interested parties into the auction process
Broadcast Letter/
Teaser
1 Confidential Information
Memorandum 3
1
Broadcast Letter/
Teaser
2
Confidentiality Agreement
3
Confidential Information
4
Management Presentation
5
Exclusivity
6
Definitive Agreement
7
Shareholder Lock-up